Tuesday, August 21, 2007
a return to ordinary central banking
Under Alan Greenspan, the former Fed chairman, the primary solution to financial crises, from the October 1987 stock market crash to the 1998 Long Term Capital Markets hedge-fund blowup to the bursting of the tech-telecom bubble in 2000, was to slash the fed funds rate. That provided cheap money to the deserving and the feckless alike, and gave rise to the notion of the so-called Greenspan Put -- an insurance policy for speculators when markets went bad.
But Friday's action of lowering the discount rate a half percentage point, to 5¾% from 6¼%, adheres to the first principles of central banking going back to Walter Bagehot -- lend freely in a crisis, albeit at a penalty rate to ensure these borrowings aren't abused. The Fed's target for the fed-funds rate remains unchanged at 5¼%.
In that, the Bernanke Fed returns to the practices under Paul A. Volcker, Greenspan's predecessor and arguably the most effective chairman in the Fed's history.
greenspan's legacy may well be that he was the ideologue who so stupidly believed in the rationality of market operators that he ended up complicit in and even instigating the greatest debt bubble of modern times -- and quite possibly, as a result, the genesis of a painful depression.
bernanke has, thusfar, been a different player. lee adler has tracked the tight policy of the fed this year, as it has actually withdrawn money supply over the last year and injected no new money supply for more than a day or two during this crisis. eventually, i suspect, government will be compelled to bail out big banking -- the balance sheet damage to the sector as a result of the mortgage-backed securities problem is more than considerable. but the consequences of the bailout itself may yet be a dagger in the american financial system.